China Trip Q&A Part 1: Autos Key Themes

From April 1st to 4th Fitch Solutions met with clients in China, including national carmakers and supply chain companies, to present our key themes for the sector in 2019, as well as presenting at the 'RepairX' event on technology and innovation in the industry. Below is a selection of the questions we received in the Q&A segment following the presentations, along with our responses.

Is leasing positive for car sales and could it be a way to boost sales in China?

Leasing is supportive of car sales under the right conditions. It is appealing as it gives consumers the option to have their own car without having the full cost of buying it outright and without ownership costs such as maintenance. However, it is better to suited to consumers with consistent mileage as there is often a cap on miles travelled in leasing agreements and it is also a better option when interest rates are low to keep it affordable. It is this last point that made leasing attractive in major developed markets such as the US and Europe after the global financial crisis as credit was cheap and supported consistent growth in these mature markets. In a market such as China, where vehicles sales on credit are a smaller proportion of sales, it does provide a growth opportunity.

We would note, however, that there is also a longer term downside to leasing, which the US is currently experiencing. When these leases come to an end, assuming the consumer does not want to buy the vehicle to keep it, we see a large number of relatively new off-lease vehicles coming into the second-hand market, which are cheaper than brand new models. This starts to take demand away from the new sales market, so leasing can provide short-term support but with longer term risk.

Are Europe and the US far behind China in promoting EVs and why is that?

China is far ahead of Europe and the US in pushing EV adoption because of its centralised and comprehensive policy for the industry, in response to the congestion and pollution challenges in the country. Incentives have supported purchases, manufacturers and increased the number of chargers. As such we expect China to maintain its position as the world's biggest EV market over our 10-year forecast period, with EVs accounting for 10% of total sales at over 3mn units by 2028.

In contrast, it has been harder for Europe and the US to put such policy into place. Europe is a very fragmented market where regulation is passed at EU level, but national governments are then faced with the challenge of how to meet these targets and for less affluent markets it is harder to fund subsidies and infrastructure. Likewise, in the US, federal support has been less forthcoming under the Trump administration and the subsidies previously in place have not been extended, while emissions and fuel economy standards are likely to be frozen rather than progressed. Some states, such as California, are providing their own EV incentives, but with a lack of centralised strategy, we forecast EVs to account for only 2% of total US sales by 2028.

EV Policy Creates Contrasting Adoption Rates

EV Sales As % Of Total Sales

National Trade Associations, Fitch Solutions

Brexit: Why are so many components imported to the UK from the EU? Is there a difference in technology level?

The difference in supply chain between the UK and EU is not necessarily based on technology, but more the cost effectiveness of access to the European market. According to the Automotive Council UK's June 2017 survey on car manufacturers' sourcing of locally produced components, local content made up 44% of the total value of vehicles produced in the UK, up from 36% in 2011 (see chart below). However, this 44% local content is still far below the 50-60% rules of origin requirements that are normally the benchmark of most contemporary free trade agreements according to the head of the UK's Society of Motor Manufacturers and Traders (SMMT), Mike Hawes.

Local Suppliers Gaining Ground Fast Enough?

% Share Of Total Auto Parts Sourcing By Origin

Automotive Council UK

The majority of supplier investments and the gains in the share of local content since 2011 are largely the result of investing in activities that would be considered 'low hanging fruit' - activities whereby there is a very strong rationale for investing in the UK rather than overseas markets for products. These investments are mostly focused on components that are delivered on a 'just-in-time' basis where proximity of suppliers to vehicle assembly plants and speed of delivery are critical. For carmakers and suppliers to invest in other types of components, the rationale is far weaker given that European and other global producers can produce them at lower costs.

What types of cars are popular in South East Asian markets such as Thailand and Indonesia?

Policy is driving the popularity of certain vehicle types in these markets. Thailand has long been the region's hub for one-tonne pick-up trucks as a result of supportive industry policy and so sales of these vehicles are still popular. In the first two months of 2019, there were five pick-up trucks in the top 10 best-selling models. However, thanks to another policy, the 'eco-car programme', these trucks share the top 10 with small cars such as the Honda Jazz and Mazda 2. Similarly, in Indonesia, the 'low cost green car' (LCGC) policy has incentivised producing and buying small cars with low emissions in the country, making smaller cars popular here too. In 2018, LCGC models accounted for around 20% of total vehicle sales.

A few companies are planning to cut back production in China. Will more cut back or leave if sales continue to decline?

There have been reports that brands such as Hyundai and Kia are considering closing plants in China on the back of weakening sales in the country (see 'Quick View: China's Weakness Causing Automakers To Grow Increasingly Skittish', March 11). However, we believe there are a number of factors to be considered before saying this signals a mass exodus from China. Firstly, the scale of a company's production and sales in China. Even if its sales fall, is the company still selling enough that it is more cost competitive to continue producing in China? Added to that, what type of vehicle is being produced in China? Is it a small low-cost model that could be produced more cost effectively elsewhere, such as South East Asia? Finally, the trade backdrop. If the US maintains or increases tariffs on vehicle imports, is it still more cost effective to produce in China, even if a company is selling a smaller volume? Therefore, we think there are too many moving parts at the moment to say if it will be a common trend for carmakers to suspend production in China, it will depend on their product portfolio and the scale of operations.